working paper no.13: problem debt and poverty · issues, and children missing out on activities...
TRANSCRIPT
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Working Paper no.13:
Problem Debt and Poverty
August 2012
Purpose
1. This paper was prepared to provide the EAG with an overview of how family
indebtedness may be contributing to child poverty. There have been several recent and
comprehensive New Zealand studies on this topic. This paper summaries key elements
most relevant to child poverty, but does not attempt to replicate those reports here.
2. This paper has informed the direction and recommendations of the EAG’s Solutions to
Child Poverty in New Zealand: Issues and Options Paper for Consultation. These are
preliminary findings, and a final report will be published in December 2012. The findings
in this paper do not necessarily represent the individual views of all EAG members.
3. The EAG wish to acknowledge the members of the Secretariat for their work on this paper.
Overview
4. The purpose of this background paper is to provide an overview of the issue of problem
debt and its effects on children. The paper also considers possible ways of alleviating the
high debt levels experienced by many low-income families.
5. Many New Zealand families are in some form of debt – 64 percent of single families
(single individual with or without dependent children) and 82 percent of couple families
(two individuals in a social-marital relationship with or without dependent children).
Mortgage debt alone makes up a significant amount of family debt – 69 percent for single
families, and 82 percent for couple families (Families Commission (FC), 2008). The Living
Standards Survey 2004 revealed that 30 percent of all families interviewed had
experienced at least one of six defined forms of ‘financial strain’1 (FC, 2009b).
6. However, it is important to differentiate between ‘normal’ and ‘problem’ debt, i.e. those
who have debt but manage it well, and those who are unable to for various reasons.
There are many factors that lead to debt going from manageable to ‘problem’. As the
Families Commission report (2009a, p.6) rightly points out, “debt can potentially be a
1 The six defined forms of financial strain are: a) not being able to keep up with electricity, gas or water costs, b)
not being able to keep up with mortgage or rent, c) not being able to keep up with hire purchase or credit card payments, d) having to borrow money from family or friends, e) receiving help from a community agency, and f) selling belongings to meet everyday living costs (FC, 2009b, p.8).
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problem for any family in New Zealand, but it is likely to be worse for families who are on
limited incomes; are without assets; do not possess the skills and resources needed to get
out of debt; and whose options to improve their financial situation are limited”. Thus, it is
important to consider the level of debt in relation to a family’s income, and their capacity
to service the debt.
7. This paper will specifically focus on ‘problem debt’, as the increased struggle to make
ends meet from the pressure of excessive debt can have far-reaching consequences for
children. It will firstly define the differences between debt and problem debt and their
causes, discuss the pros and cons of various means to mitigate problem debt, and offer
some practical solutions.
Definition – problem debt
8. The Families Commission (2008) defines debt as: “Any financial obligation, leveraged
against an asset (secured debt) or against future income (unsecured debt)… [for example]
mortgages, student loans, bank loans, hire purchase, credit cards, store credit, being in
arrears and use of fringe lenders” (p47).
9. Problem debt, however, is defined as “unmanageable debt leading to financial strain”
(Families Commission, 2009a, p6). The Families Commission report (2009b) puts problem
debt into three categories:
a) a family is lacking sufficient income to cover their expenses, and does not have
access to, or has already exceeded/exhausted, financial options such as overdraft or
credit cards
b) a family is experiencing financial strain despite having access to debt or formal lines
of credit – that is, they are currently exhausting the financial debt options available
c) a family not only has high debt levels, but is in a negative equity position (liabilities
are greater than assets) (2009b, pp7-8).
10. Unfortunately, while we have data on the overall level of debt (as noted above), there is
no information specific to problem debt or debt for families living in poverty.
Impacts of problem debt on children living in poverty
11. The effects that problem debt can have on children are far-reaching and well documented
(Valins, 2004). Problem debt is a significant barrier to families enjoying a meaningful life
where children can flourish and reach their full potential in society.
12. Children in families with problem debt have less money to meet essential needs such as
food, clothing, and other housing expenses. There are also negative impacts on family
well-being – such as increased strain on family relationships, stigma and mental health
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issues, and children missing out on activities that are generally perceived to be normal
(FC, 2009a).
How people get into debt
13. There are numerous ways that families get into debt. In a qualitative study interviewing
27 beneficiary and 13 working families, the Families Commission (2009a) identified the
following reasons for accumulating problem debt:
a) inadequate income to meet basic needs – low levels of education mean earning
potential can be limited
b) rising price of necessities (e.g. food, power, rent, transport)
c) family member with a significant health issue or physical or mental disability – issues
were the cost of care and time spent out of the workforce
d) certain spending behaviours – three behaviours were identified:
i) lack of control with personal spending. “Problem debt [is] often related to
consumption rather than asset accumulation” (FC, 2009a, p7).
ii) helping other family members
iii) alcohol, drug, gambling addiction
e) spiralling debt – one initial debt leading to other debts
f) experiencing a major change of circumstances – changes included having a child,
buying a home, change in employment or income
g) lack of financial literacy, leading to take-up of high interest loans from finance
companies
h) being in debt to the government.
Debt to the government
14. The government has a significant role as a collector of debts through the Inland Revenue
Department (e.g. child support payments), Work and Income (e.g. benefit related
payments/advances), Ministry of Justice (e.g. Court-imposed fines), Housing New Zealand
arrears, and infringement fines through local councils, the Police, and other prosecuting
authorities (e.g. speeding tickets, parking tickets, dog registrations fees, etc).
15. According to Valins (2004, p69) “fines appear to be a relatively small but still significant
component of the monies owed by people who have debt problems.” Court fines are the
most widely used penalty for offenders; making up 33 percent of all convictions in 2001.
Judges consider fines to be a useful sanction for minor offenses, but are also concerned
at the number of people who are brought before the Courts who cannot afford to pay
them. A key contributing factor to this, according to Valins (2004), is the increase in
‘instant fines’ (e.g. traffic, parking, dog control, underage drinking etc.). While fines are
fairly easy to administer, they do not discriminate on the basis of a person's ability to pay
and a series of minor fines can easily mount up quickly from one initial offence – e.g. a
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seatbelt fine ($150) leading to an unregistered vehicle fine and no warrant of fitness fine
($200 each), etc. Judges cannot impose fines on offenders if they cannot be expected to
repay them within a reasonable timeframe, yet fines for vehicles are fixed and not means
related. A Judge quoted in Valins’ report commented that such an approach brings the
system of justice into disrepute.
16. Penalties are added onto fines if they are not paid in time; further compounding problem
debt for those on low incomes. If recipients of a fine do not pay within 28 days, it is
passed on to the District Court with a $30.67 filing fee. After the next 28 days an
enforcement action fee of $102.22 is added, after which the Court can take enforcement
action to collect the debt. This can include:
compulsory deductions from wages, benefit, or bank account
the seizure and selling of property
preventing overseas travel
arresting the debtor (Ministry of Justice, 2012).
17. Applications can be made to the Court for an extension of the due date or to make
payments by instalments. Financial information about the debtor is usually needed to
make sure there is a genuine need to grant further time to pay. It would be useful if there
were greater capacity to take individual cases to a Judge to get approval for a debt write-
off (currently the high level of authorisation means that it is only done in rare cases).
However, it would also be useful to consider other models, as Judge-only processes are
time consuming and costly.
18. Berkana Consulting Services (2002, cited in Valins 2004, p47) identified debt to
government departments as one of three factors that lead to financial crises for former
beneficiaries. In the study, of those former beneficiaries who were indebted to Work and
Income, 34 percent stated that it was due to mistaken benefit overpayments, 27 percent
were late in notifying Work and Income that they had a job, 23 percent had received
emergency grants, and 23 percent had received advances on benefits.
19. The New Zealand Christian Council of Social Services (NZCCSS, 2008) undertakes
qualitative research into foodbank usage. Using Hamilton as an example, Table 1 sets out
the type of debt foodbank users had in 2004, highlighting debt to Work and Income. The
majority of foodbank users have a benefit as the sole form of their household income.
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Table 1: Hamilton Combined Christian Foodbank applicants in debt, 2004 and 2007
Debt type 2004 2007 Percentage
change
% of applicants on benefit as sole form of household income
85% 84% -1%
% of applicants in debt 77% 89% 16%
% of applicants in debt to Work & Income
63% 71% 12%
Number of clients paying over $40/w to Work & Income 25 22 -12%
% of applicants in arrears on utility bills 31% 6% -79%
% of applicants in arrears with electricity bills
22% 25% 14%
Survey Sample 367 348 -5%
SOURCE: (NZCCSS, 2008).
Recommendation 1:
The government should review its debt accumulation and recovery processes for low-
income families to ensure they take the well-being of children into account.
Recommendation 2:
The government should explore whether a whole-of-government approach could be
applied to assist households with debt to more than one government department.
Options for addressing problem debt
20. There are various options for addressing problem debt amongst low-income families. The
following sections consider the regulation of credit, provision of budget advice and
financial literacy services, and social lending.
Access to credit and the accumulation of debt
21. Loans from finance companies are often a problematic form of consumer credit, with high
interest rates, additional administration costs, and strict repayment times. Loan sharks,
fringe lenders, and mobile shops are prevalent throughout low income areas, such as
South Auckland and Porirua East. The ease with which these loans are able to be taken
up, especially by those with poor credit ratings, has serious implications for debtors.
Interest rates are commonly very high. Sometimes people use the entire contents of their
house as collateral (Francis, 2012).
22. Interviews undertaken by the Families Commission (2009a) revealed that some families
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did not always understand the contracts for credit advances that they signed. Others
knew the risks but felt they had no other alternatives. Common reasons for taking out
consumer credit loans are for vehicle-related costs (repairs, repossession), whiteware or
technical equipment, pay day advances, and funeral costs. A common amount borrowed
by survey participants to cover immediate costs was $100, leading to repayments of $160
- $180 (after interest) within a two to four week period.
Consumer credit legislation
23. One of the most practical ways to combat the issue of problem debt is through the
regulation of financial loan companies that lend to those on low-incomes and are active in
low socio-economic areas. Unlike many other countries (such as the United States,
Canada, and Australia), New Zealand does not use regulations to set upper limits on the
interest rates charged by loan agencies.
24. In New South Wales, Queensland, and the ACT a cap of 48 percent per annum is imposed
on credit contracts regulated by the Uniform Consumer Credit Code (UCCC). In Victoria, a
cap of 48 percent is imposed on unsecured credit and a cap of 30 percent imposed on
secured credit regulated by the UCCC (Howell, 2009). While these may still be very high,
they are nonetheless a good starting point in considering future options. They are
certainly better than the current situation where finance companies are charging interest
rates of up to 400 percent.
25. However, the evidence suggests that introducing interest rate caps on financial loan
companies has mixed success, and often brings with it unintended consequences. One of
the greatest risks is greater financial exclusion. If a lender is constrained in the rate of
interest they can charge, they will not lend to anyone whose rate of risk they calculate to
be above the cap. If lenders can’t lend according to risk, this could also lead to higher
prices for all customers. Interest rate caps are often described as a 'blunt instrument'
since not all high interest loans are necessarily unfair or result in over-indebtedness, and
not all consumers may underestimate the risks of high cost credit.
26. Changes to the New Zealand Credit Contracts and Consumer Finance Act 2003 (CCCFA)
are currently under consideration. In April 2012, a Consultation Draft was released
detailing lender responsibilities as a new principle in the CCCFA, and strengthening the
legal rights and protections of consumers when they borrow money (Ministry of
Consumer Affairs, 2012b). The CCCF Amendment Bill is expected to be tabled in
Parliament in September 2012.
27. The proposed amendments to the CCCFA will likely include introducing a Responsible
Lending Code for creditors (e.g. contract transparency, making it illegal to lend where
repayments would likely cause substantial hardship, and allowing for lenders to be
banned from the industry for non-compliance (see: Cabinet Business Committee, 2011));
extending the ‘cooling off’ period from three to five days; better control of misleading
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advertising; and borrowers not having to pay the cost of interest or fees if their lender is
not a registered financial service provider.
28. The specific measures in the proposed amendments to deal with loan sharks and fringe
lenders are: credit offered must be reasonably expected to meet the needs or purposes of
the borrower; the borrower must be reasonably expected to repay the loan without
substantial hardship; and the lender must be honest and transparent in dealing with the
borrower (Ministry of Consumer Affairs, 2011a).
29. A major concern regarding the proposed amendments is a lack of any mention of an
upper limit on the interest rates that can be charged by finance companies. As
unscrupulous lenders make most of their money through very high interest rates, not
including limits in the proposed amendments could undermine effectiveness of
regulations.
30. The Ministry of Consumer Affairs (2011a) noted the following issues with imposing caps:
A limit set too high can result in that limit being a price goal for lenders, thereby
increasing the overall cost of credit to users of fringe services.
A limit set too low leads to lenders leaving the market, potentially channelling
borrowers to inappropriate credit products (black market/illegal money lenders).
If a cap is introduced at a level insufficient to generate a lender's required
margin, the price of credit can be transferred from the interest rate into fees and
other charges, thereby negating the intention of the price control.
31. Enforcement of price controls, including interest rate caps, is expensive and difficult to
administer. A European Commission report found interest rate caps tended to reduce
access to credit, particularly for low-income borrowers; reduce the choice of products
available to consumers; and increase the overall cost of credit in parts of the market. The
study also found little evidence that credit price restrictions helped to reduce over-
indebtedness.
32. Thus, there is no clear view on what approach to interest rate caps works. After
evaluation of overseas experiences which appear to confirm the arguments for not
introducing interest rate caps, the Ministry of Consumer Affairs does not support such a
policy. However they have stated that they will continue to monitor this issue.
Changes to repossession laws
33. In April 2012, the Law Commission released a report on consumers and repossession.
The Law Commission (2012) recommends wide-ranging changes to New Zealand’s credit
repossession laws, with a view to establishing a fairer, more transparent and efficient
regime for all parties. Under the proposed changes, consumers entering credit contracts
would have to be told explicitly when repossession could occur, and which goods could
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be repossessed. The Commission also recommends that goods such as bedding, washing
machines, and portable heaters, as well as passports and identity documents, should not
be subject to repossession at all. If the Commission’s recommendations are accepted by
the Government, in the future repossession agents will need to be licensed and could
lose their license for breaching the new laws. The Commission is recommending that the
Credit (Repossession) Act 1997 Act be repealed and that provisions covering the
repossession and sale of goods be incorporated into the Government’s proposed
amendments to the CCCFA.
34. The EAG supports the Law Commission’s recommendations to changes in New Zealand’s
credit repossession laws.
Budget advice and financial literacy services
Budget advice services
35. Families interviewed by the Families Commission believed that budgeting services had
made positive improvements to their financial situation (Families Commission, 2009a).
36. The Minister of Social Development, Hon Paula Bennett, recently announced a one-off
funding boost of $589,000 from the Ministry of Social Development (in addition to the $8
million annual funding currently allocated for these services) for 155 community groups
that provide budgeting services. However, a major provider of budgeting advice, the
Salvation Army, reports that it is struggling to cope with the increasing number of people
using its services (33 percent increase in 2012 and 52 percent in the last three years). It is
clear that despite the $8 million annual funding to community budgeting advice
providers, and the recent one-off funding boost, funding for this essential service is
currently not keeping pace with demand.
Recommendation 3:
The government should increase funding for budget advice services to keep pace with
demand by low income families for these services.
Financial literacy
37. The second ANZ-Retirement Commission Financial Knowledge Survey, conducted in 2009,
is a benchmark for assessing adult financial literacy in New Zealand. It found that there
was an overall improvement of financial knowledge since the original survey conducted in
2005. However, 16 percent of respondents indicated that they had difficulty managing
money, with 26 percent of those with a lower level of financial knowledge having
difficulty. People in the low-knowledge group (31 percent of the total) were more likely to
be: 18-24 years old; Māori or Pasifika; only primary or secondary educated; tenants, not
homeowners; unemployed; in semi-skilled occupations; and low-income.
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38. Evidence shows that financial literacy is an effective tool for people to avoid getting into
problem debt. The Families Commission report (2009a) noted that a number of its survey
participants lacked financial management skills, which led to them entering into loan
schemes that resulted in high debt accumulation. Budget advisors have noted an
intergenerational lack of financial literacy amongst families they deal with.
39. Addressing the lack of financial literacy should be a priority. One practical way to make
progress would be to implement a nation-wide educational campaign that is primarily
targeted to low-income and beneficiary families. Currently the Sorted campaigns
(conducted by the Commission for Financial Literacy and Retirement Income) are largely
aimed at middle-class families. For instance, a recent poster campaign had an ‘average’
household’s weekly budget at $1200, more than double that of many low-income
families.
40. Financial literacy is being introduced incrementally into the schooling system. There is
currently a National Strategy for Financial Literacy with the Ministry of Education and the
Commission for Financial Literacy and Retirement Income is taking a lead role in its
implementation. Work is underway with various education providers and private sector
associations, and financial literacy courses have been introduced into the New Zealand
curriculum. However a progress update by the Commission for Financial Literacy and
Retirement Income (2011) noted that “on the Ministry of Education’s TKI website there
are resources for teachers but they are not as widely used by teachers as we would like.
The Ministry is currently developing resources for teachers which show how financial
concepts and behavioural economics can be integrated into the social sciences learning
area.”
41. Although some progress is being made, the EAG welcomes ongoing initiatives from
government in this area that will accelerate progress.
Recommendation 4:
The government continue to implement a nation-wide education campaign on financial
literacy, with a specific focus on low-income and beneficiary families in the community
and at schools.
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Social lending
42. Social lending is where “an organisation provides no or low cost loans to people where a
social benefit, rather than a profit, is the main outcome. It is not well developed in New
Zealand but there is an increasing appetite for it” (Ministry of Consumer Affairs, 2011b).
These community organisations have an important role to play as they fill the void
between banks who will not lend to those with bad credit or little ability to meet loan
conditions, and predatory loan sharks who charge high interest rates.
43. There is a role for the government to encourage and support philanthropic social lending.
A discussion paper from a recent financial summit on social lending (Ministry of Consumer
Affairs, 2011b) recommended the following:
a) Social lending should be encouraged. Any social lending model will need
adaptation to meet the needs of New Zealanders. Clear criteria need to be
established regarding loans for necessities as opposed to wants.
b) Partnerships between communities and non-finance groups with financial
organisations – be they banks, second or third tier lenders, and especially credit
unions, perhaps with some funding and promotional assistance from government.
c) The government should aim to reduce compliance costs to social lending
initiatives and to make the process as easy as possible. Increased compliance is
likely to mean that lenders would have to adopt the same approaches as first tier
lenders have already, which low income customers find confusing and
inappropriate.
Good Shepherd Microfinance
44. A good example of social lending is the Australian based Good Shepherd Microfinance
(GSM). As a community finance-credit organisation, GSM helps those living on low
incomes and financial hardship through microfinance programmes. Microfinance is
defined as “the provision of financial services – such as loans (microcredit) and savings
accounts (microsavings) – to people on low and limited incomes who can’t easily access
mainstream financial services” (GSM, 2012). GSM has four main services: the No Interest
Loan Scheme (NILS); StepUp (low interest loans); AddsUp (matched savings program);
and Good Money (community finance hubs).
45. NILS offers interest-free loans to the value of up to $1,200 for essential household goods
and services. Repayments are made in affordable amounts for a period of between 12
and 18 months. In 2011 18,000 NILS loans were issued with a borrower default rate of
less than 5 percent.
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46. StepUP provides low interest loans to individuals and families on the Family Tax Benefit
Part A, or a holder of a current Centrelink Concession Card. StepUp offers loans between
$800 and $3,000 for personal or household purposes such as car repairs, furniture,
medical and housing expenses etc. Interest is charged at a fixed low rate, and loans can
be repaid over three years with no added fees.
47. AddsUp is a savings plan in collaboration with the NAB which helps those on low incomes
to develop financial independence. The scheme matches savings of $300 or over dollar
for dollar up to $500.
48. Good Money community finance hubs incorporate services such as NILS, StepUP and
financial counselling, which offer customers a more integrated way of accessing financial
assistance and support. Good Money is a socially responsible alternative to fringe
lending.
49. In order to help develop and facilitate its services, GSM has a number of corporate and
business partners, including: the Federal Government’s Department of Families, Housing,
Community Services and Indigenous Affairs (FaHCSIA) (which oversees more than 220
accredited community organisations to deliver NILS loans); the National Australia Bank
(NAB); and the Victorian and Queensland Governments.
50. The Federal Government’s 2011 Budget allocated $18 million over three years to GSM for
no interest and low interest loan schemes, including NILS and StepUP. This funding helps
to subsidize overhead costs (including the salaries of some of the staff employed to
manage the loans) and research to assess the impacts of the various schemes. The NAB
has committed $130 million for the expansion of NILS to over 400 outlets nation-wide,
and is the principal partner of the StepUp and AddsUp programmes. The funding from
the NAB involves an implicit subsidy of several million dollars per annum, and forms part
of its philanthropic activities. The Victorian Government has committed $6.7 million since
2006, with the Queensland Government providing $1.2 million during 2008-2010 and
ongoing support for NILS worker training, marketing and coordination.
51. It is interesting to note that the NAB owns the Bank of New Zealand (BNZ). Thus, there
may be some potential for the NAB to expand its microfinance services into its New
Zealand subsidiary. Aside from this, other banks in New Zealand, such as Kiwibank, have
expressed interest in the GSM model and there are a number of local charitable
organizations that are keen to collaborate with GSM.
52. While a predominant view amongst the social lending sector is for it to operate outside of
the realm of government (Benedict, 2010), the GSM example shows that there is a
practical role for the government (or perhaps local government) to play in providing
funding and support to microfinance schemes. Indeed, the Australian evidence highlights
that a great deal can be achieved (under the appropriate conditions) with only a modest
financial contribution from the state. Benedict notes that “government will want to
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provide some direct funding in order to help the private social lending system accomplish
some of the government’s goals” (2010, p.50).2 It is to be hoped that this sentiment
might apply in New Zealand.
Recommendation 5:
The government should investigate a private-public-partnership model with the banking
sector and community groups to establish schemes similar to those operated by Good
Shepherd Microfinance.
2 Laura Benedict has many other recommendations for government involvement in the social lending sector,
including tax policy, charitable status, and regulation of financial markets. Due to the length of some of these recommendations and their complexities, this paper will not attempt to summarize them, but readers are encouraged to refer to Benedict (2011), especially pages 45-60 for the roles that government can play.
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